by Doug Kass
Markets tend to make opinions. There is a strong inclination and nature to extrapolate as “group stink“ is the favorite market odor.
So, it can be expected that most investors enter the year optimistically – thinking once again of a new paradigm and long boom (reminiscent of Peter Schwarz and Peter Leyden, Wired Magazine (1997) article, ” The Long Boom: A History of the Future, 1980-2020 “
The predominant view is that there is nothing that can derail the train of higher economic and profit growth and stock prices.
But, as was the case in prior cycles, sometimes the identification of headwinds is hiding in plain sight: too much debt (and cheap money), elevated valuations, too much market complacency and/or enthusiasm (hedge funds are more leveraged today than at any time since 2008 and short interest as a percentage of market capitalization is under 2%, the lowest reading in five-six years), the massive global volatility short in place, a widening wealth and income gap, political and geopolitical uncertainty and, even a relaxation of ethical standards.
And, of course, in plain sight are the growing speculative excesses and pocket of bubbles in bitcoin and cryptocurrencies.
A friend reminded me over the weekend of something Karl Marx famously wrote that history always repeats itself — the first time as tragedy, the second time as farce.
If the dot.com bubble was a tragedy, the bitcoin bubble is likely a farce — with the usual suspects including Asian traders/gamblers, day traders, failed hedge fund managers and millennials with little experience who tell us grey beards that we don’t get it!
Let me start the year with some of my core expectations for some of the major asset classes (I will follow up with explanations and more during January):
- * Corporate Profits: Will be buoyed by a “one-time accounting change” of a lower instituted corporate tax rate but will disappoint relative to consensus expectations.
GAAP Non GAAP
2016A $94.55 $106.26
2017E $114.70 $124.90
2018E $132.50 $142.50
- Domestic Economic Growth: I am projecting US Real GDP growth to range between +2.5% and +2.75%, again below the consensus – as the benefits of “tax reform” trickle up but not down.
- Despite High Expectations, There Will Be No Meaningful New Legislation out of Washington in 2018: Only one reconciliation is permitted per year, so the Democrats control the play of the field. Partisanship will intensify even more this year. With DACA important to the Democrats and welfare reform important to the Republicans, growing animus between the parties and an important mid term election in November — there will be a complete legislative impasse. There will likely be no infrastructure bill or anything incrementally important to our economy or society. The Republicans will likely lose the House – further adding to the gridlock.
- The Markets: Equities will no longer be detached from the fixed income markets – as shrinking central bank balance sheets should weigh on stocks. My anticipated S&P Index range is 2200-2800. That’s a downside to upside (from Friday’s close) of -18% to +5%, a negative ratio of 3.6:1.
- Fed Funds: I am projecting a year end 2018 rate of 2.25% to 2.50%.
- Bonds: I expect a range on the ten year US note yield of between 2.30% and 3.00%.
- Volatility: VIX range of 8-35.
- Foreign Exchange: Euro range of $1.08 to $1.22. Yen range of 115/132.
- Gold: Could make an all-time high in 2018.
- Oil: Spikes to $80 a barrel as underinvestment meets geopolitics meets some kind of nature-driven problem in the oil supply chain.
- Bitcoin: By year-end, cryptocurrencies will be assigned to stock market history’s garbage pile of speculative failures. I am projecting a year end 2018 price at under $2,000.
As I recently wrote:
“The year 2018 will be one in which investors come to understand that blockchain technology — a distributed database of records of transactions that are executed and shared among participating parties and are validated by a network of users, called “miners,” who contribute computing power in exchange for the chance to garner coins using a shared database and distributed processing — is real (each transaction is encrypted and can’t be replicated or altered), but that bitcoin is a mirage and becomes, like many past schemes, a byword for Ponzi-like nostalgia.” – Surprise #4, 15 Surprises for 2018
Herewith, my complete 15 Surprises for 2018.
More Surprises for 2018 From Byron Wien
Byron Wien issues his Surprises for 2018.
- China finally decides that a nuclear capability in the hands of an unpredictable leader on its border is not tolerable even though North Korea is a communist buffer between itself and democratic South Korea. China cuts off all fuel and food shipments to North Korea, which agrees to suspend its nuclear development program but not give up its current weapons arsenal.
- Populism, tribalism and anarchy spread around the world. In the United Kingdom Jeremy Corbyn becomes the next Prime Minister. In spite of repressive action by the Spanish government, Catalonia remains turbulent. Despite the adverse economic consequences of the Brexit vote, the unintended positive consequence is that it brings continental Europe closer together with more economic cooperation and faster growth.
- The dollar finally comes to life. Real growth exceeds 3% in the United States, which, coupled with the implementation of some components of the Trump pro-business agenda, renews investor interest in owning dollar-denominated assets, and the euro drops to 1.10 and the yen to 120 against the dollar. Repatriation of foreign profits held abroad by U.S. companies helps.
- The U.S. economy has a better year than 2017, but speculation reaches an extreme and ultimately the S&P 500 has a 10% correction. The index drops toward 2300, partly because of higher interest rates, but ends the year above 3000 since earnings continue to expand and economic growth heads toward 4%.
- The price of West Texas Intermediate Crude moves above $80. The price rises because of continued world growth and unexpected demand from developing markets, together with disappointing hydraulic fracking production, diminished inventories, OPEC discipline and only modest production increases from Russia, Nigeria, Venezuela, Iraq and Iran.
- Inflation becomes an issue of concern. Continued world GDP growth puts pressure on commodity prices. Tight labor markets in the industrialized countries create wage increases. In the United States, average hourly earnings gains approach 4% and the Consumer Price Index pushes above 3%.
- With higher inflation, interest rates begin to rise. The Federal Reserve increases short-term rates four times in 2018 and the 10-year U.S. Treasury yield moves toward 4%, but the Fed shrinks its balance sheet only modestly because of the potential impact on the financial markets. High yield spreads widen, causing concern in the equity market.
- Both NAFTA and the Iran agreement endure in spite of Trump railing against them. Too many American jobs would be lost if NAFTA ended, and our allies universally support continuing the Iran agreement. Trump begins to think that not signing on to the Trans-Pacific Partnership was a mistake as he sees the rise of China’s influence around the world. He presses for more bilateral trade deals in Asia.
- The Republicans lose control of both the Senate and the House of Representatives in the November election.Voters feel disappointed that many promises made during Trump’s presidential campaign were not implemented in legislation and there is a growing negative reaction to his endless Tweets. The mid-term election turns out to be a referendum on the Trump Presidency.
- Xi Jinping, having broadened his authority at the 19th Party Congress in October, focuses on China’s credit problems and decides to limit business borrowing even if it means slowing the economy down and creating fewer jobs. Real GDP growth drops to 5.5%, with, only minor implications for world growth. Xi proclaims this move will ensure the sustainability of China’s growth over the long term.Also-rans:
Every year there are always a few Surprises that do not make the Ten because either I do not think they are as relevant as those on the basic list or I am not comfortable with the idea that they are “probable.”
- Investors recognize that the earnings of companies in Europe, the Far East and the emerging markets are growing faster than those in the United States while the price earnings ratios in those regions are lower than those in America. Global investments become more broadly represented in institutional portfolios.
- The Mueller investigation of the 2016 presidential election fails to implicate any members of the Trump familyin collusion with Russian operatives.
- Artificial intelligence gains visible momentum. Service sector jobs are automated, particularly clerks in legal and finance professions, as well as workers in fast food outlets and healthcare. Economists begin to question the unemployment data because the rate drops below 4% while so many people still appear to be out of work and seeking government assistance.
- Cyberattacks become more prevalent and begin to affect consumer confidence. A major money center bank suspends deposits or withdrawals for three days because its system is penetrated. Numerous retail organizations report that customer personal information has been obtained by hackers. Those invading corporate information systems appear to be smarter and more innovative than the internal employees protecting the computer data, suggesting that the systems themselves need to be upgraded.
- The regulatory authorities in Europe and the United States finally get concerned about the creative destruction of Internet-related businesses. As a result of pressure from retailers and traditional media companies, they begin an investigation of anti-competitive practices at Amazon, Facebook and Google. The public begins to think these companies have too much power.
- The risks in Bitcoin are so great that regulatory authorities restrict trading. Among their concerns are: no regulatory overnight; no safety and soundness measures; no recourse in the event of mistaken or miscalculated transactions; high cyber risk; no deposit insurance. (Risk source: Morgan Stanley.)
Since 2004 Doug Kass has served as President of Seabreeze Partners Management, Inc. He runs a hedge fund and individual managed accounts, co-authored “Citibank: The Ralph Nader Report” with Ralph Nader and the Center for the Study of Responsive Law in the 1970s and wrote “Doug Kass: A Life on the Street” two years ago (John Wiley). Since 2003 Mr. Kass served as a guest host on CNBC’s “Squawk Box” and has guest hosted Bloomberg’s “Market Surveillance” for the last five years. Along with Jim Cramer, Doug is the principal contributor to Real Money Pro.